Tempur Sealy International, Inc.

Good morning, and thank you for standing by. Welcome to the Tempur-Sealy second quarter 2023 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising you your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Aubrey Moore, Investor Relations. Please go ahead.

Thank you, Operator. Good morning, everyone, and thank you for participating in today's call. Joining me today are Scott Thompson, Chairman, President, and CEO, and Boster Rowe, Executive Vice President and Chief Financial Officer. After prepared remarks, we will open the call for Q&A. This call includes forward-looking statements that are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve uncertainties, and actual results may differ materially due to a variety of factors that could adversely affect the company's business. These factors are discussed in the company's SEC filings, including its annual reports on Form 10-K and quarterly reports on Form 10-Q under the heading special note regarding forward-looking statements and risk factors. Any forward-looking statement speaks only as of the date on which it is made. The company undertakes no obligation to update any forward-looking statement. This morning's commentary will also include non-GAAP financial information. Reconciliations of this non-GAAP financial information can be found in the accompanying press release, which has been posted on the company's investor website at investor.temperaceli.com and filed with the SEC. our comments will supplement the detailed information provided in the press release. And now with that introduction, it is my pleasure to turn the call over to Scott.

Thank you, Aubrey. Good morning, everyone, and thank you for joining us on our 2023 second quarter earnings call. I'll start by sharing some highlights from our second quarter performance, and then Bhaskar will review our worldwide financial performance in more detail. After that, I'll share some closing comments before we open the call up for Q&A. Today, we are pleased to report one of the strongest second quarters in the company's history, second only to the same period in 2021. Importantly, these results were delivered against headwinds from a less favorable market than we expected, the impact of which was partially mitigated by company-specific performance. Sales growth for the quarter was 5%. Adjusted EPS for the quarter was consistent with prior years after absorbing higher interest costs, major launch costs, and elevated taxes. Gap EPS grew 2%. We believe these results are a reflection of our innovative products, strong sales culture, solid expense controls, and our passion for execution.

In our largest market, the U.S.,

we believe industry units declined at least low double digits in the quarter, resulting in historically low aggregate industry volumes for the quarter and first half of the year. Overall, we believe the U.S. market has stabilized at trough unit levels, with the upper end of the market demonstrating a bit more resilience compared to the entry-level market. Today's results demonstrate the robust earnings power and cash flow attributes of the business as we realize solid earnings and cash flow against this challenging backdrop. As we look to the back half of the year, we anticipate U.S. produced mattress unit trends will slowly improve but remain negative year over year.

FOSQR will have more information on the 2023 guidance in a minute. Turning to a few highlights for the quarter.

First, we continue to extend our lead as the largest global bedding company in the world. All three of our leading U.S. brands, Temper, Sealy, and Stearns and Foster, performed well in the quarter, significantly ahead of where we believe the industry trend is. We were pleased with the second quarter performance of our international business. The successful Temper International launch, combined with Dreams' crisp retail execution, are driving continued outperformance worldwide and positioning us well for the future. Second, we opened our third domestic foaming pouring plant in Crawfordville, Indiana, expanding our manufacturing capacity to meet expected demand for years to come. We designed the state-of-the-art facility to optimize our manufacturing capabilities across bedding products and components. In addition to pouring Tempur-Pedic material, we have the flexibility to leverage the plant's foaming pouring capacity to manufacture bedding products and components for our Sealy and Stearns and Foster brands, as well as our non-branded OEM operations. The facility enhances our ability to service our customers in the Northeast market, creating opportunities to shorten lead times and reduce per unit logistics costs. This plant also provides additional storage for chemicals, mitigating the risk of future supply or pricing disruption. With the opening of this facility, we've completed our three-year strategic capital at CapEx program and expect to see CapEx investments moderate significantly going forward. In the second half of this year, we expect CapEx to be down by 50% versus the same period last year, certainly beneficial to free cash flow.

Third highlight, we completed the rollout of our new Tempur-Breeze products and our new smart base in the US.

Next generation Tempur-Breeze mattress built on the success of our proven legacy Breeze products to deliver next level sleep solutions with enhanced Tempur-Pedic feel characteristics. Featuring new technologies designed by our Tempur-Pedic scientists, the new lineup presents the next generation of consumer-centric solutions focused on helping to alleviate aches and pains. We also continue to raise the bar in cooling performance with our new Lux Breeze model, feeling 10 degrees cooler all night long, presenting the best-in-class solution to the more than 60% of the households that have at least one person who sleeps hot. Retailers and consumers' response to these incremental technologies have been overwhelmingly positive. And we and retailers are seeing positive mix and higher average ASP. In tandem with the breeze mattress refresh, we also introduced an updated adjustable base lineup, which is driving all time high retailer advocacy and attachment rates, reaching new records in May and June. Our new smart base features our new sleep tracker 2.0 technology. the accuracy of which was validated by a Stanford medical study and offers industry-leading automatic snore detection and response, addressing a leading sleep concern among consumers. This new lineup also features incremental multi-sensory relaxation features to help consumers wind down and prepare their bodies and minds for deep, mood-rejuvenating sleep. Over the Memorial holiday, we supported these temper lineups with all new Breeze and SmartBase multimedia advertising campaigns. These efforts drove incremental search interest in Tempur year over year and drove solid e-commerce traffic trends over the Memorial Day selling period. All of our new Tempur products and supporting advertising initiatives are strengthening Tempur's appeal to the premium, wellness-minded consumer and driving improvements in attach rates and ASP for our third-party retailers. Fourth highlight, our investments in Stearns and Foster products and distribution and marketing continue to drive meaningful sales growth and expand brand recognition. In the second quarter, Stearns delivered its third sequential quarter of year-over-year sales growth, significantly outperforming broader market trends. This was possible thanks to the recent investments in brand and the rollout of our all-new Stearns and Foster collection, with superior innovation and elevated design and enhanced step-up opportunities.

The new product lineup is delivering strong results.

We've grown Stearns' third-party retail distribution by more than 20% compared to the previous collection, with gains in both legacy and incremental Stearns retailers. We're seeing this product resonate with the historically underserved premium innerspring consumer, resulting in strong mix and, again, driving ASP expansion. Our channel diversification strategy is also driving strong brand momentum. The Stearns and Foster e-commerce site we launched last year continues to drive brand recognition and highly profitable incremental sales.

Finally, our launch of our all new international temper products continue to track with our expectations. We are launching a new international lineup in over 90 markets worldwide.

In the first half of the year, we kicked off our temporary European and Asian markets. We expect to be fully floored in our last market in the UK in the first half of 2024. The UK has some country-specific fire retardant regulations, which adds some complexity to the product launch. The consumer-centric innovation and new collection will appeal to our legacy ultra-premium consumers at prices of $3,000 and above, while also broadening our price points to expand our addressable market to meet the need for consumers shopping for mattresses between $2,000 and $3,000. We are streamlining the manufacturing process for this lineup to unlock this incremental price point without materially altering the margin profile of our temper international business. As we continue to stagger the rollout by individual markets, we're currently manufacturing both the new line and the old line of products in our international temper plan. We plan to optimize production of the new line after the transition period, providing a tailwind to gross margins in 2024.

Now I'll turn the call over to Bostrick. Thank you, Scott.

In the second quarter of 2023, consolidated sales were approximately $1.3 billion, and adjusted earnings per share was 58 cents. We have approximately $13 million of pro forma adjustments in the quarter, all of which are consistent with the terms of our senior credit facility. These adjustments are primarily related to cost incurred in connection with the planned acquisition of Mattress Firm, a $4 billion U.S. bedding retailer. Turning to North American results. Net sales increased a solid 5% in the quarter. On a reported basis, the wholesale channel increased 6% and the direct channel increased 3%. North American adjusted gross margin improved to 39.9%, driven by pricing actions and favorable commodities, partially offset by increased product launches and operational headwinds. North American adjusted operating margin improved to 17.4%, driven by the improvement in gross margins. Now turning to international. International net sales increased 3% on a reported basis, and 4% on a constant currency basis. Our current year full year expectations for 2023 contemplates neutral FX, both the sales and adjusted EBITDA. As compared to the prior year, our international gross margins improved to 54.9% driven by favorable mix and pricing actions. Our international operating margin declined to 13.4%. driven by launch-related expenses, including discretionary advertising investments, partially offset by the improvements in gross margin. Global commodity prices continue to trend largely in line with our expectations. We continue to expect favorable commodity prices into the back half of the year, though remaining significantly elevated to 2020 levels. Now moving to the balance sheet and cash flow items. At the end of the second quarter, consolidated net debt was $2.7 billion, and our leverage ratio under our credit facility was 3.1 times, slightly ahead of the target range of two to three times. We expect to return to our target leverage range in the back half of the year. We generated second quarter operating cash flow of $150 million. In total, we had more than $250 million of operating cash flow in the first half of the year, continuing to demonstrate the attractive cash flow attributes of the company. As expected, our inventory levels declined in the quarter as we have completed the vast majority of our domestic product launches. This resulted in a sequential six-day improvement in the cash cycle. As we enter the back half of the year, we expect inventory levels to further decline as well as some improvements in working capital, further improving our cash cycle. We have temporarily suspended repurchases under our share repurchase authorization as we work towards closing the matches firm transaction. Over this interim period, we expect to significantly deleverage as we plan to use the cash to pay down debt ahead of the closing. After the acquisition closes, we would anticipate our leverage ratio to be between three and 3.25 times. Now turning to 2023 guidance. Due to revised industry expectations, we are trimming the midpoint of our 2023 guidance by approximately 3% on both sales and adjusted EPS. We now expect adjusted EPS to be in the range of $2.50 to $2.70. This considers sales to be consistent to slightly up over the prior year. This includes the execution of our key initiatives, new product launches, and the wraparound impact of pricing. This also assumes global industry headwinds primarily in the low end. Sales and marketing investments of $20 million to support our product launches. and maintaining our commitment to record advertising spend of over $500 million as we continue to support our leading brands and new products. This will result in adjusted EBITDA of approximately $940 million at the midpoint of the range. Our guidance also considers the following allocations of capital in 2023. A quarterly dividend of 11 cents, representing an increase of 10% relative to 2022, and CapEx of approximately $200 million, which includes $90 million of growth CapEx, primarily to fund the completion of our Crawford Field facility. I should note that going forward, we expect our CapEx to return to a more normalized level of spend. We think of annualized CapEx as approximately $150 million, driven by maintenance CapEx of 110, and growth CapEx of approximately $40 million. Lastly, I would like to flag a few modeling items. For the full year of 2023, we expect DNA of approximately $190 to $200 million, interest expense of about $135 to $140 million, a tax rate of 24 to 25%, and a diluted share count of 178 million shares. With that, I'll turn the call back over to Scott.

Thanks, Pastor. Great job. Before opening the call up for questions, I want to provide a couple of updates.

First, I want to address the cybersecurity event affecting certain parts of our IT system, which was disclosed Monday in our 8K. Following the discovery of the event, our team activated Its CEO approved incident response and business continuity plans. The plan was approved years ago, and it's designed to contain incidences. The plan included proactively shutting down certain IT systems, resulting in the planned temporary interruption of our operations. We began bringing our systems back online last Friday and expected to take time to return to normal operations. Our investigation remains ongoing, and we continue to work to determine the impact of the disruption. If we determined that any personal information was involved, we would of course comply with any reporting obligations we have under the applicable law. Currently, we're working hard to catch up with the lost production from the shutdown. In total, our systems were down for a week, and we are currently working to get back to full production. We expect the cyber-related expenses met will be adjusted from our third quarter financial results. Lastly, I'd like to provide a brief update on our pending acquisition of Mattress Firm. We're currently responding to the Federal Trade Commission's second request and continue to expect to close the transaction in mid to late 2024. Over this interim period, Mattress Firm's leadership team provides us with a high-level update of their financial performance. Mattress Firm's recently quarterly results, which they reported yesterday, were consistent with our expectations, and we look forward to bringing the Mattress Firm team on board.

And with that, I'll open up the call for questions, operators.

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, Press star 1-1 again. Please limit yourself to one question and then re-queue. Please stand by while we compile the Q&A roster. Our first question comes from Bobby Griffin with Raymond James. Your line is open.

Good morning, everybody. Thanks for taking my questions, and congrats on a good quarter with a lot of moving parts. Thanks, Bobby. I first want to just maybe follow up on the guidance reduction and just maybe get a little more clarity on some of the moving parts assumed in there. So is the reduction in earnings and sales all just a function of the industry maybe being a little bit softer than we originally anticipated and we laid out? Or are you baking in some conservatism that this IT event or the cyber event will have some type of impact on earnings and revenue in the second half?

Yeah, let me answer. It's a little bit of a long answer, but let me be clear about it. First of all, from the cyber event, great job by the internal IT department. They did a great job. In fact, it was an enterprise-wide effort, and congratulations to all the people internally. We also had a lot of help from external IT teams that we had on retainer for these kind of events, and a great job by Microsoft's elite team. Let me kind of go through the estimates of what we know today. Obviously, this is not an easy estimate, but let me tell you what we know based on all the information that we have right now. First of all, the event itself is certainly not material to the intrinsic value of the enterprise. The event is not material to our 2023 expected sales or EBITDA. Before insurance, and we have an insurance limit of 5 million, but before any insurance, our best estimate is about 10 to $20 million negative impact in EBITDA in the third quarter. We expect the vast majority will qualify as an add back adjustment in the third quarter. In the estimate that I gave you on the impact of EBITDA, it really breaks out into kind of two pieces. You know, one, which is clearly incremental cost related to the activity and should be cleared by covered by insurance at some point. But, of course, we'll count for that as we receive it. And then 50% of it is from potential lost sales. When you look at the potential lost sales for the third quarter, you're talking about 20 to 30Million dollars. That's about maybe 2%-ish, give or take, of the quarter sales. And again, that's potential. And the vast majority of that would be Sealy U.S., because we had plenty of inventory in the temper organization. We've not experienced any material changes in our balance of share. And retailers, quite frankly, have been very understanding in the situation. Now, lastly, more kind of directly to your guidance question, you know, for the 2023 guidance, the event has been considered. But as we mentioned before, we would expect an add-back in the third quarter for the cost. And certainly, we'll account for that. The insurance, whenever we ever file a claim, we'll call that out. Any other impact on changing the guidance? Totally macro. When we look at the second quarter and, okay, let's say we kind of scraped out the second quarter, the market wasn't as strong as we expected it to be, but we also performed better and outperformed the industry by a greater extent than we expected. And when you net the two, we had a relatively solid, in fact, very solid relative to others in the industry in the second quarter. And looking forward, we brought back, we brought down our expectations for the industry. And that required us to fine tune 3 percentage from a guidance standpoint.

Thank you. Our next question comes from Susan from Goldman Sachs. Your line is open.

Thank you. Good morning. Thanks for taking the questions and congrats on a good quarter. Thank you. Yeah. I think, you know, staying on the theme of demand, Scott, as you think about the macro setup with rates possibly at or very close to the peak, housing getting a little better, feels like maybe the consumer will start reengaging and spending in some of these other categories as travel starts to moderate a bit in there. How are you thinking about the industry's ability to start to see some level of improved demand as we move through the next couple of quarters and your ability to continue to outperform relative to that as some of your peers perhaps move up off of these industry declines of the 25%, 30% range.

Thank you for the 33 questions you asked me, Susan. Let me speak to it and see if I can answer like 30 and leave three unattended. First of all, we're very happy with the performance of the quarter, and we think it gives us an opportunity to show the strength of the business, even in a little bit of a down cycle in its cash flow generation. I would highlight in our numbers, because this goes to the consumer question you asked, If you look at our ASP, it was up 13% in the quarter. And all but about, it's called 2% of that's price. The vast majority of that is people mixing up. And so what that would tell you is the top end of the consumers are doing very well. And where you're seeing sales pressure is at the lower end. If I do it by brand standpoint, our high-end brands did better than our low-end brands, i.e. Stearns and Foster did better than Sealy. And Stearns and Foster grew double digits in a market that, I don't know, pick your number, but it was clearly down double digits. It grew double digits. So I'm going to say the strength of the high-end customer, everywhere we looked, looked very good. We look at individual mattresses within the temper lineup. The high-end temper products did much better than the low-end temper products. We continue to be fairly bullish on a high-end customer where you feel the pressure is in the low end, and the low end has gotten hit very hard. So, you know, you had a question in there about outlook as far as consumers going forward. We've been bouncing around the bottom in the betting industry for probably three quarters. And so I don't know, next quarter or two, we certainly think that the industry should start doing better. Some people can point to green shoots. Yeah, we see some, but you have some good weeks and you have some slower weeks. But the main thing from our perspective is we see our products incrementally performing very well in the marketplace against the competition. Any part of her question I missed, Oscar, that you can remember? How about competitive landscape? Competitive landscape, look, we've got, it's a very competitive market. There's lots of competitors embedding worldwide. Other brands that have brand strength that we all know, they're out there, they're competing every day. I haven't seen anything in any of the competitors that I would call a significant sea change in their activities or their strategy. But it's a competitive market, and we'll continue to compete the best we can.

Thank you. And we have a question from Keith Hughes with Truist. Your line is open.

Yeah. You had talked earlier about raw material costs. It's coming down. Can you give me a kind of quantification of how much they're down, either in the quarter or your estimates for the second half of the year? Absolutely. Dollars would be helpful.

Sure. So let me think about it this way, is that we did have an expectation from a commodity standpoint as we entered the year. Largely speaking, those commodities are coming in very much in line with our expectations. We would expect to continue to see incremental commodity benefit as we get into the back half. However, all contemplated in our initial thoughts. as it relates to what we thought commodities were going to do. As it relates to the commodity benefit that we saw in our GP rate is we'll have a little bit more information. Our queue is going to drop here in a little bit, but I'll go ahead and give you a peek on it. It's from a commodity standpoint is what we wanted to expect to see is about 150 basis points of improvement.

Thank you. Our next question comes from Curtis Nagel with Bank of America. Your line is open.

Hi, this is Steven McDermott for Curtis Nagel. Just for your match firm acquisition, I know you called out kind of second half of 2024. Is there any changes in what you are seeing from a regulatory approval standpoint? And then as far as gross margins kind of touch beyond just the commodities, how are we thinking about the cadence going into 2H and kind of all the puts and takes there? Thank you.

Yeah, thank you for your question. I'll do FTC and I'll give Captain Margin the question on margins. Look, as you know, the FTC process is long and complex. What I would say is we're working through the process. There have not been any surprises. In the process, we're providing them significant information on their second request. Lawyers and folks are meeting and discussing professionally as we both learn each other's perspective. And I think that process will continue to go on for several months. And probably sometime in the fourth quarter, we'll probably get down to the point where we figure out whether or not we have a meeting of minds or we don't have a meeting in mind. But I would tell you that process is progressing normally. Everybody's working cordially together. And they have responsibility on their side that we certainly respect. And we look forward to continuing to visit with them.

When I think about gross margins going from the first half to the second half, first thing I would point out is I would anticipate the normal seasonality of the business. Generally, the second half is bigger than the first, so therefore, we get some leverage upon our fix. So clearly, I would anticipate that that would happen. In addition to that is that we had some unique events that were investments that we made in the first half, whether it be product launch expenses, whether it be the floor models that we have out there. So as we get into the back half of the year is that that's not going to be a headwind from a gross margin standpoint. And then finally, I will call out is that we've been making – some investments in our supply chain and our operations. Let's call that we've been filling some EBITDA to make sure that we've been servicing our customers. And as we think about the back half of the year is that those headwinds should turn into tailwinds. So what all that means is what I would anticipate is that gross margin continues to step up with Q3 being the highest at the year. Then I would also say, as we think about our just margins overall from a go forward standpoint, is that I feel like we have a number of tailwinds to margin, whether it be the product mix, whether it be the operational initiatives that we have, not only this year, but as those could continue. We're very excited about our direct-to-consumer business. DTC should be a tailwind for us from a go-forward standpoint. And then finally, I'll close it down with international. International is we spent many, many years in developing a product that will hit a new total addressable market. Generally, international margins are higher than the U.S., so I anticipate as international markets Uh, continues to grow is that that will be a tailwind as well.

Yeah, the only thing I made me think as you were talking about is the margins that we probably should have called out in the 2nd quarter. Our advertising expense, we spent the same amount as last year. I, even though the market was choppy. We didn't pull back on advertising to try to optimize it or something like that. And in fact, if you look at our direct advertising, our direct advertising to support quite frankly, a little week for market is is up double digits in the 2nd quarter in support of the marketplace.

Thank you. Our next question comes from Peter Keith with Piper Sandler. Your line is open.

Hey, good morning, everyone. Congrats on the continued share gains. I guess a two-part question, hopefully related. Number one, could you give us the sales lift in the second quarter from the product launches that you had? And then secondarily, it looks like now your guidance supplies of revenue is going to slow in the back half. At the same time, I think the industry trends, what we're seeing general agreement on is that things are getting less bad. and you're kind of guiding for things to get worse. So hopefully you could reconcile that dynamic.

I'm sure you want to work on that a lot. Absolutely. So the way I would think about it is specifically as it relates to floor models in the second quarter, let's call that 2% to 3%. And so that's the look we got there. What I think about the back half, reasonable as it relates to what the back half looks like from a scale standpoint. However, here's the way I think about it. is in the first half of the year, we did have some benefit from the last round of pricing actions that we took in 2022. That lapsed in the first half, meaning that we don't have that benefit as we think about the back half of the year. Finally is that our floor models, which are again, are gonna support future growth is that those are largely in the first half of the year. So when you think about our expectations in the back half of the year, what that does imply is that from an organic standpoint, Is it that those initiatives are going to continue to allow us to grow in a very challenged market? So, how I think about that is from a sales being flat to slightly up is what that would imply in the back half of the year is that we would see a bit of growth and really being fueled by those initiatives in a very challenged market.

One moment for our next question.

Our next question comes from Seth Basham from Wedbush Securities. Your line is open.

Thanks a lot and good morning. I have a follow-up question to Peter just on the outlook for the industry for the balance of the year. If you take into consideration what's happening from a macro standpoint and a credit availability standpoint, What are you expecting industry units to do for the full year and for the back half of the year that underpins your guidance?

Good question. So the way we think about it is let's call it mid to high single-digit decline. And what that would imply is for the back half of the year, call it mid-single-digit decline. It's our expectation that for the second quarter, is that when the information comes out, our estimate is that we'll see low doubles from a decline standpoint.

Thank you. And our next question will come from Brad Thomas with KeyBank Capital Markets. Your line is open.

Hi, thank you. A couple of follow-ups, if I could. Scott, I believe you talked about thinking that You may not have as much from share gains in the back half as what you've been seeing in the first half. I was wondering if you could elaborate on that any more. And then, Bhaskar, I was hoping you could talk a little bit more about the commodity component of margins and maybe how you're thinking about that from a big picture standpoint and perhaps maybe how that sets up as a potential tailwind for you even as you move into 2024. Thanks.

Yeah. Thanks for the question, and let me be a little clearer. It's more the way we do budgeting more than expectation when it comes to share gains or outperformance in the marketplace. Clearly, we continue to have quite a bit of outperformance in the marketplace. But when we actually put our budgets together and we do guidance, we don't anticipate that activity. We let that activity flow into the numbers. As a good guy, maybe it offsets an unknown bad guy. But as far as like, you just asked me like, okay, what do you really think your share gains are going to be? We haven't seen anything in the marketplace from any of the competitors that would make us think that our share gains would slow down. All of our brands had really strong second quarter, and we haven't seen anything that would make us think that the that wouldn't continue in the third quarter. So that's probably me misspeaking or thinking about our budgeting process more than anything else.

As it relates to the components of gross margin, just cleaning up one of the questions that I got earlier from Keith, let's call it about $15 million of commodity benefit in the quarter, and that will triangulate to about the 150 basis points of rate improvement. As we think about commodities, largely speaking, is that we had a perspective on what the full year would look like. and what we assume there is that we continue to see some favorability as the year progressed. Within some puts and takes, I would say largely is that that is coming in as in and around what we would anticipate. So what that does imply for the rest of the year is that we continue to see on a sequential basis commodity improvement as well as obviously year over year as well. Now, all that said is that we are still well off our 2019 levels from a commodity standpoint. So when you think about that mathematical equation that was happening where we had taken price and without any gross margin that would fall through from a rate standpoint, is that phenomenon is still there. Yes, we have recouped some of that as commodities have come in. However, we are well, well off of where we used to be from a historic standpoint, commodity prices versus 2019. you would anticipate with the fullness of time is that things would normalize. However, it would be, I think there's some things that are just going to be more stickier than others as it relates to getting back to those pre-pandemic levels.

Thank you.

Our next question comes from Atul Myasrawari from UBS. Your line is open.

Good morning. Thanks a lot for taking my question. Bhaskar, just to follow up on the commodity piece of gross margin, based on your estimate as it stands today, how much of a, if I back up a step, I think in the past what you've mentioned is that commodities have collectively been a 400 basis points headwind to gross margin over the last few years. As of the end of 23, How much of that do you expect to recover just so that we can properly calibrate what's left outstanding for 2024 and beyond?

Sure. Let me do that math kind of as I'm thinking about it. So I think we're well off of where we were in the pre-pandemic levels. I don't think we're approaching, let's call, half of where we were before, so somewhere between 150, 200 basis points perhaps. Is what we've captured, and that's consistent with what we've seen, let's call it in the 1st, half of the year. So I anticipate that to play through a little bit and really that reinforces the point is that things are things are better than where they were obviously during the pandemic. However, just from a pure inflation standpoint is that we still got a ways to go.

Thank you.

We have a question from Laura Champagne with Loop Capital. Your line is open.

Thanks for taking my question. If I look through the quarter that Mattress Firm just reported, it looks like their sales declined 6%. Do you view them as holding on to market share in a weaker market, or is there an issue there that you would need to turn around should you become the owner of the Mattress Firm assets recognizing that it would be a year?

Sure. We don't have all the information yet that we get in the marketplace to fully answer that question. But certainly the early indications are that, you know, from a retail perspective, I suspect the retailers were down double digits in total. I'm looking at Bhaskar to agree because we don't have all the numbers we triangulate. And so they were down 6% in sales and up, I think, 3% in EBITDA sales. in a market that I would say probably sales for retailers were double-digit. So I think they probably took a little bit of share. If you were to segregate the market between what I'll call the big retailers and the small retailers, they were probably, I'll call it, in line maybe with the large retailers, because generally the trend has been larger retailers have been taking share from smaller retailers. Their report, which is their third quarter, our second quarter that came out last night, was very much in line with our expectations of what they were going to do this year, pre-signing the definitive agreement. So they're tracking to our internal expectations.

Thank you. Again, if you would like to ask a question, please press star 11 on your telephone. Our next question comes from William Reuter from Bank of America. Your line is open.

Hi. Good morning. I just have one. Given a little bit of the weaker demand at the lower end and lower commodity prices, do you expect that you may either be more promotional? Do you expect you would reduce list prices? Have your retailer partners come to you with any suggestions on how to increase volumes there? That's it.

Thanks. No, I don't really see any pricing actions at the lower end. Is it promotional? Yes. The low end is always very promotional. And in the industry, the low end doesn't have much profit in it. So there's not a lot to work with. at the low end, and where we've seen retailers aggressively try to promote and drive, we'll call it lower end. Generally, we've seen those activities not be successful from a return on advertising or promotion dollars. The low end market is just not there right now. Again, maybe in marketing terms, the fish aren't there right now. So, no, but as far as, but are we continually looking for ways to help stimulate the market? Yes. But I don't think it's really a pricing issue. But, you know, if I, you know, got to be king for the day, what I'd like to see is, you know, more advertising in the marketplace by, you know, other manufacturers and others to help, you know, just stimulate activity because I think there's There's quite a bit of dollars out there in the middle of the market and the upper end of the market, but entry levels just tough right now.

Thank you. And our last question comes from Carla Casella with JP Morgan. Your line is open.

Hi. I'm wondering about inventory and working capital and your thoughts. Third quarter I know is usually a big cash flow quarter. for you. Do you think, are you expecting that again this year and for the full year? Do you still expect working capital relief? And do you expect to be able to fully pay down your revolver in the next quarter?

Absolutely. Here's the way I would think about it. So we made some investments in working capital as we exited 2023, whether it be in advance of the new product introductions that we have, as well as just carrying more safety stock as the supply chain was a little uncertain at that time. As we sit here today, our cash cycle, we've seen some nice improvements, specifically about six days in inventory. As the year plays out, what I would anticipate is that we would see some continued improvement in working capital overall, a little bit from inventory, but I would expect something from the other components as well, that being payables and receivables. As we exit the year, what I would anticipate is that working capital will continue to be a source of cash. And let's say from a historic standpoint is that the flow through on EBITDA to cash flow is we should continue to see that same relationship. Absolutely, the back half of the year is that we generate more cash than the first half. So I would say that we would expect that again this year. What I would further say is that we feel very excited about what we've done from a new plant standpoint that's in Crawfordsville. That was a $300 million investment in growth CapEx that we made over the last couple of years. And we're very excited to say that we've got some units coming out of that plant. Also, what that means is from a cash flow standpoint, a free cash flow, is that that investment is behind us. So on a year-over-year basis, free cash flow should be greater by about 50% than what it was in the prior year.

And then I guess the other part is we're not doing stock buyback while we're preparing for the mattress firm acquisition. So we're going to be drowning in cash and the leverage ratio should be falling significantly over the next few quarters.

That's right. I think what we're anticipating is obviously in this, we'll get back within our range in the third quarter. As we sit here today, I would expect to be somewhere at the midpoint of our range of two to three as we exit the year.

Thank you. And we have one last question from Brad Thomas with KeyBank Capital Markets. Your line is open.

Oh, thanks for taking the follow-up question. A couple of things that investors have been asking us this morning, I was wondering if I could ask. For one, you know, it's been an exciting year with some new retail partnerships like Sam's Club. Scott, I was just wondering if you could give us any update on distribution and how, you know, partnerships are going and floor space. And then secondly, just a question on the cybersecurity issue. Is the expectation that operations are normal for the Labor Day selling season, or do you think it goes into that at all? Thanks again.

Well, congratulations on slipping in one more question and then making it a five-point question.

Well done.

So let me get back to this. So first of all, you mentioned a large customer, SAMS. We think that that's going well. And we think that if you ask them, they would say it's going well. So we're thrilled with that relationship. I think you know that Stearns and Foster captured 20% increase in slots. And we certainly feel good about that. And clearly from our sales numbers relative to the industry, whether you want to compare it to other public companies or spring volumes or anything, we're clearly taking share Uh, so, you know, floor space is increasing and velocities within those slots, uh, you know, have, have been increasing. Um, and then I think he asked a little bit more about like, kind of, where is the organization cyber thing? Yeah. I mean, look, uh, we obviously have the eight K out, uh, we're generally building and shipping beds. I mean, right now we're taking orders, uh, right now, uh, we in generally lost about a week's worth of production, you know, around the world. And then as we bring up the systems, it usually takes a few days to get back to kind of normal efficiency. So yeah, I don't know. We also had some parts of the organizations that weren't impacted by any of the cyber event, like the Asian Joint Venture, Dreams, Sherwood, Sleep Outfitters. They weren't affected at all. Our worldwide e-commerce, it wasn't affected except for a bit slow shipping. So, no, I mean, I think we're working off backlog, but I think we're going to get caught up and I don't really expect to leave the third quarter with any significant backlog. So I don't think it's going to have an impact. And we've certainly tried to work through that when we gave you estimates of the impact of the event.

Thank you. That's all the time we have for questions. I'd like to turn the call back to Scott Thompson for closing remarks.

Thank you, operator. To our over 13,000 employees around the world, thank you for what you do every day to make the company successful. Special call out again to our IT folks, in a very difficult quarter and a great job in dealing with the uncertainty that we faced. To our retail partners, thank you for your outstanding representation of our brands. To our shareholders and lenders, thank you for your confidence in Tempur-Sealy's leadership team and its board of directors. This ends the call today, operator.

This concludes today's conference call. Thank you for participating. You may now disconnect.